Non-QM RMBS grows and stretches
admin | April 4, 2019
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Rapid growth in issuance of non-QM RMBS has started to stretch the boundaries of the sector. Issuance has quadrupled so far this year from the same time last year, but growth has come with an increasing population of high LTV loans, higher borrower debt-to-income ratios and more loans with limited or alternative documentation. Borrower credit scores remain strong, and increased tail risk shows up in some but not all major non-QM issuers. Fortunately, spreads in the sector have widened, adding some cushion for the added loan risk.
Rising LTV ratios are not unique to the non-QM market. Robust home price appreciation over recent years has driven average LTV ratios higher across agency MBS and CRT as well as private-label prime jumbo deals. Simply looking at average original LTVs in non-QM trusts, however, does not show any material rise (Exhibit 1).
Exhibit 1: Average original LTV across non-QM trusts
The distribution of loans by LTV and vintage tells a different story, however. Populations of 80-90 LTV loans have risen from 18% of all collateral backing non-QM trusts in 2016 to 27% of total collateral in 2018. Most of the rise in higher LTV loans has been at the expense of 60-70 loans, which have fallen from 23% of total collateral in 2016 to just 19% of all loans last year. While the amount of high LTVs loans continues to grow, it does not appear to be at any expense to the quality of those loans as FICO scores have been consistently in the low 700s across vintages.
Exhibit 2: Non-QM issuance by vintage and original LTV
Looking across the four largest non-QM issuers, the most pronounced increase in 80-90 LTV loans come from the Angel Oak, Caliber and Deephaven shelves with a much smaller bump in Invictus’ VERUS shelf (Exhibit 3). While Caliber’s COLT shelf has seen the largest increase in high LTV loans, COLT has also seen the most pronounced increase in credit scores on those loans, rising from an average of 702 in 2016 to 715 last year.
Exhibit 3: Original LTV distribution by issuer and vintage
Higher DTI loans have also become a larger part of non-QM loan collateral. Loans with debt-to-income ratios greater than 40 made up 31% of all loans in non-QM trusts in 2016 and 44% of all loans last year (Exhibit 4). A few details:
- Loans between 45 to 50 DTI made up an additional 8% of 2018 collateral, but average FICO scores jumped by 13 points from 696 to 709.
- Loans between 50 to 55 DTI rose by 4% but FICO scores remained flat, potentially raising concerns about layered risk in high DTI loans.
Exhibit 4: Non-QM issuance by vintage and DTI
Caliber’s COLT shelf saw the largest percentage increase in 40 to 45 DTI loans, increasing from 8% of 2016 collateral to 27% of loans securitized in 2018. While the shelf had the most dramatic increase in those loans, they had an average FICO score markedly higher than those with comparable DTIs in other programs. Looking at that DTI bucket across the four major issuers in 2018 Caliber’s loans had an average FICO of 721, markedly higher than those of Angel Oak, Deephaven or Verus who’s comparable loans had average FICO scores of 703, 696 and 704 respectively. (Exhibit 5)
Exhibit 5: Debt-to-income ratio distribution by issuer and vintage
More limited or alternative documentation
Over the past two years the population of full documentation loans has been giving way to limited documentation or loans underwritten using other methods like asset depletion or debt service coverage to qualify. The population of full doc loans in non-QM trusts tends to be volatile making up as much as two thirds of early issuance and less than a quarter of loans securitized in 2017.
Unfortunately, underwriting and documentation across shelves with the most alternative documentation are not uniform and as such it makes it somewhat challenging to make truly equivalent comparison of risks in limited or alternative documentation loans. Simply looking at 2018 issuance would suggest that limited and alternative documentation loans in Invictus’ VERUS program may be the least risky given an average 720 FICO and 67 original CLTV. Slightly better than Deephaven’s limited documentation loans that had an average 712 FICO and 72 origial CLTV. Non-full doc loans in the COLT and Angel Oak programs had average FICOs of 709 and 705 and original CLTVs of 78 and 79 respectively.
Compensation for risk
This leads to the question of whether the changing risk profiles of these pools are being priced accordingly. We do not expect the changing collateral profiles of these deals to impact the AAA classes of these deals from a loss perspective, any material deterioration in collateral performance would impact the AAA classes from a mark to market perspective. Looking at the historical spread relationship between non-QM AAA bonds and current coupon 15-year pass- throughs, a comparable duration agency asset, shows that currently non-QM AAA spreads are roughly 25 bps wider than they were to that agency benchmark this time last year suggesting that the market has commanded a meaningful incremental risk premium for the changing credit profile of the asset class on a relative basis. (Exhibit 6)
Exhibit 6: Average spread between non-QM AAA and current coupon 15-year